Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—Tex. App.: Morgan Keegan’s investment risk disclosures deemed inadequate, (May 20, 2016)

By Jay Fishman, J.D.

The Texas Court of Appeals, while not granting investors’ attorney fees request, affirmed the trial court’s decision for them against Morgan Keegan & Company, Inc. and Morgan Keegan Asset Management, Inc. for not adequately disclosing certain investment risks (Morgan Keegan & Co. v. Purdue, May 18, 2016, Francis, M.).

Adequacy of risk disclosure. In 2004, the investors, a husband and wife, purchased from Morgan Keegan more than $2 million in Purdue Avenue Investors’ bond funds. Morgan Keegan & Co. was the funds’ underwriter and Morgan Keegan Asset Management, Inc. was the investment adviser that managed the portfolios. Starting in 2007 when the global financial crisis began, the funds lost over $2 billion, and the investors lost their entire investment. The investors did, however, recover $2,683 from the Texas State Fund and $155,135.50 from Purdue.

In 2009, the investors filed suit in Texas trial court alleging Texas Securities Act and common law fraud violations. The investors contended that while Morgan Keegan’s oral statements and prospectuses contained the typical risk disclosures for bond funds, they misstated that these bond funds were diversified when, in fact, the funds were 60 to 70 percent invested in mortgage- and asset-backed securities. The investors also claimed that the funds failed due to being so highly invested in real estate and that the investors would have never purchased them had Morgan Keegan disclosed this.

Morgan Keegan argued that the loss of the funds was caused solely by the financial collapse, which affected all funds no matter their type, and not by the investor’s particular bond funds being so heavily invested in real estate.

The trial court ruled in favor of the investors except on their request for attorney fees, and both parties appealed.

Statute of limitations. Morgan Keegan asserted that the applicable three-year statute of limitations had lapsed by virtue of the five-year gap between the investors’ bond fund purchase in 2004 and their filing suit in 2009. The investors contended that the correct gap was actually less than three years, from 2007 when the bond fund value began to drop and 2009 when they filed suit. The investors claimed they could not have discovered that their bonds were lower tranch funds than other low bond funds until 2007 when the sharp decline occurred. Moreover, the investors’ expert witness testified that the principal investment strategy and principal associated risks were not disclosed until the funds lost 65 percent of their value in 2007. The appellate court found that the investors’ and expert witness testimony was not so weak as to render the trial court’s finding wrong and unjust.

Erroneousness of trial court rulings. Morgan Keegan contended that secondary liability against it under the Texas Securities Act failed because the trial court erroneously concluded that Morgan Keegan was primarily liable as the issuer of the bonds. The appellate court acknowledged this trial court error but considered it a small mistake that could be corrected to reflect the funds as the true issuer of the bonds. By making this correction, the court was able to conclude that the investors had sufficiently pleaded Morgan Keegan as the aider, abettor, and control person for the transactions and, therefore, secondarily liable for the bond fund behavior.

Trial court impartiality. Morgan Keegan argued that the trial judge should have recused himself because he made a number of comments about his boredom with the case and because of his past work with these financial transactions that allegedly disparaged Morgan Keegan’s side. But the appellate court found that the record also contained statements of the judge telling the investors’ attorney and related parties to be quiet so that he could hear Morgan Keegan’s arguments to render a fair judgment. The court therefore concluded that the judge, overall, was impartial.

Trial court’s erroneous admission of evidence. Morgan Keegan contended that the trial court erred by admitting two previous SEC orders against Morgan Keegan. But the appellate court found the exhibits to be harmless because the trial court expressly stated on the record that the exhibits were at most “some evidence of the facts found,” which the appellate court concluded did not affect that court’s decision.

Damages award not including required offsets. Morgan Keegan contended that the damages award should have been offset by the $2,683 from the Texas State Fund and the $155,135.50 from Purdue that the investors received. The appellate court proclaimed that “offset” is an affirmative defense whose burden of proof Morgan Keegan did not meet because it neither directed the trial court to any offset pleading made at trial nor requested the court to make a finding on the issue. Furthermore, Morgan Keegan did not offer any evidence at trial about the amount it requested deducted from the damage award.

Attorney fees. The appellate court agreed with the trial court’s finding that the investors should not recover their own attorney fees since there was no evidence of a special or fiduciary relationship between the investors and Morgan Keegan. The record also reflected that the trial court considered all the circumstances of the case to properly exercise its discretion in ruling that the investors’ attorney fees should not be recovered.

The case is No. 05-15-00369-CV.

Attorneys: David Clem (Kane Russell Coleman & Logan PC) for Morgan Keegan & Co. Inc. Braden W. Sparks (Braden W. Sparks, P.C.) for Purdue Avenue Investors LP.

Companies: Morgan Keegan & Co. Inc.; Purdue Avenue Investors LP.

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